As interest rates remain at their highest levels in over two decades and inflation continues to impact consumers, major banks are bracing for potential risks associated with their lending practices.
In the second quarter, JPMorgan Chase, Bank of America, Citigroup, and Wells Fargo all increased their provisions for credit losses compared to the previous quarter. These provisions represent the funds set aside by financial institutions to cover possible losses from credit risks, including unpaid debts and loans such as those related to commercial real estate.
JPMorgan allocated $3.05 billion for credit losses during the second quarter, while Bank of America set aside $1.5 billion. Citigroup’s allowance for credit losses reached $21.8 billion at the end of the quarter, more than tripling its reserves from the previous quarter, and Wells Fargo had provisions amounting to $1.24 billion.
These increased reserves indicate that banks are preparing for a more challenging environment, where both secured and unsecured loans may lead to larger losses. A recent report from the New York Fed revealed that American households collectively owe $17.7 trillion in consumer loans, student loans, and mortgages.
Credit card issuance and delinquency rates are also rising as individuals deplete their pandemic-era savings and increasingly rely on credit. In the first quarter of this year, credit card balances exceeded $1 trillion for the second consecutive quarter, according to TransUnion data. Additionally, the commercial real estate sector is facing significant challenges.
Experts note that the banking sector is still adapting to the aftermath of the COVID-19 pandemic, during which government stimulus significantly impacted consumer behavior. As a result, any challenges facing banks are expected to manifest in the coming months.
“The provisions you see in any given quarter don’t necessarily reflect credit quality for the last three months; they indicate what banks expect for the future,” explained Mark Narron, a senior director at Fitch Ratings’ Financial Institutions Group.
Looking ahead, banks anticipate slowing economic growth, rising unemployment, and two potential interest rate cuts later this year, which could lead to increased delinquencies and defaults.
Citi’s Chief Financial Officer, Mark Mason, pointed out that the warning signs are particularly evident among lower-income consumers who have seen their savings decline since the pandemic. While the overall U.S. consumer remains resilient, performance disparities persist based on income and credit scores.
Data indicates that only the highest income quartile has maintained higher savings than they had at the start of 2019. Consumers with credit scores above 740 are primarily driving spending growth and maintaining high payment rates, while those with lower scores are struggling more significantly with inflation and rate hikes.
The Federal Reserve has held interest rates at a 23-year high between 5.25% and 5.5%, awaiting stabilization in inflation towards its 2% target before initiating expected rate cuts.
Despite banks’ preparedness for broader defaults in the latter part of the year, current default rates do not indicate an imminent consumer crisis. Observers are paying closer attention to the differences between homeowners and renters during the pandemic period. Homeowners who secured low fixed-rate mortgages are less affected compared to renters facing significant rent increases.
With rents soaring over 30% nationally from 2019 to 2023 and grocery prices rising by 25%, renters who could not lock in favorable rates are finding their budgets strained.
Despite potential challenges, recent earnings reports reflect no new issues concerning asset quality, showing that revenues, profits, and net interest income in the banking sector remain strong.
“There are positive signs within the banking sector, indicating that the financial system remains robust,” said Mulberry. “However, we are closely monitoring the situation, as prolonged high interest rates may introduce additional stress.”